Commentary and musings on the complex, fascinating and peculiar world that is securities regulation

Sunday, July 22, 2012

UK FRC Calls for EU-Wide Code of Conduct for Proxy Advisory Services and Coordination with SEC

The UK Financial Reporting Council eschews EU regulation of proxy advisory
services at this time in favor of an EU-wide Code of Conduct. In a comment letter to the European Securities and Markets Authority, the Council said that proxy advisory
firms should be urged to develop a Code of Conduct, and that legislation
should be considered if they do not address current concerns. Given the
international nature of equity markets, continued the Council, it is important
that any EU action should mesh with action in the US. Thus, the FRC urged EU authorities
to stay in close contact with the SEC, which has also been considering the need
for the regulation of proxy voting agencies.
The Financial Reporting Council is the UK’s independent regulator and
standard setter responsible for corporate governance, accounting, and auditing.

The Code of Conduct envisioned by
the FRC would consist of best practices and operate on a comply-or-explain
basis. Proxy advisory firms would be required to state publicly whether or not
they apply the Code. More granularly, the Code would encourage proxy advisory
firms to disclose on a comply-or-explain basis how they approach their decisions,
how they escalate difficult or non-routine decisions within their own hierarchy,
and how far they are prepared to talk to issuers. When basic research is outsourced to analysts
in an overseas jurisdiction, the scope of such work should be clearly explained
and companies should have access to a named individual in their own time zone,
with which they can discuss any queries.

The proxy advisory agencies
should identify an individual of high public standing to provide independent
leadership to the development of the Code.
This corresponds to the model adopted by the UK private equity industry for
which Sir David Walker fulfilled this role. The Walker Report set forth
guidelines for disclosure and transparency in private equity, on a
comply-or-explain basis.

Proxy advisory firms should also
consult widely and publicly with interested parties, including issuers and
investors on the content and wording of the Code of Conduct. Once the Code was agreed to and in effect,
said the FRC, the industry should organize an objective, independent annual
report on compliance. Obviously, if the
industry failed to respond, it should be clear that pressures for formal
regulation would increase.

Concerns over the use of proxy
advisory services are compounded by the increasing internationalization of the
equity markets, noted the FRC, which results in more shareholders being remote
from the companies they own which, in turn, make them more reliant on proxy advisory
firms. It also makes it hard for
companies to engage directly with even some of their larger shareholders.

These concerns are genuine,
emphasized the FRC, and are likely to increase as the equity market becomes
more international and resource pressures push more investors to rely on the
judgments of proxy advisory services.
Agents who have no value at stake and who do not therefore need to live
with the consequences of corporate decisions could thus become a dominant force
in deciding how resolutions are voted at annual meetings, while responsibility
for the voting decision continues to rest with share owners.

Finally, the FRC cautioned that any
regulatory intervention must be set against the overall value that proxy voting
agencies bring, especially in an age where there is greater public expectation
on shareholders with regard to stewardship. For most institutional investors managing
large portfolios, the availability of a set of benchmark judgments is important
in helping them exercise their ownership responsibilities. It also acts as a filter for identifying
difficult and controversial cases.
Without the contribution of proxy voting agencies, warned the Council, there
is a risk voting could become chaotic and unpredictable.